Tax laws change frequently and increasing complexity can make it hard for high-income earners and high-net-worth individuals to stay on top of the latest tax strategies. The “trick” to minimizing your federal income tax liability is understanding the rules and making the most of your tax planning opportunities. Below are five considerations for minimizing your 2022 taxes.
TIMING INCOME AND EXPENSES
Smart timing of income and expenses can reduce your tax liability, and poor timing can unnecessarily increase it. When you don’t expect to be subject to the AMT in the current year or the next year, deferring income to the next year and accelerating deductible expenses into the current year may be a good idea because it will defer tax.
But when you expect to be in a higher tax bracket next year—or you believe tax rates may rise—the opposite approach may be beneficial: Accelerating income will allow more income to be taxed at your current year’s lower rate, and deferring expenses will make the deductions more valuable because deductions save more tax when you’re subject to a higher tax rate.
Whatever the reason behind your desire to time income and expenses, you may be able to control the timing of these income items:
- Self-employment income
- S. Treasury bill income
- Retirement plan distributions (to the extent they won’t be subject to early-withdrawal penalties and aren’t required)
Some expenses with potentially controllable timing are investment interest expense, mortgage interest, and charitable contributions.
FACTORING IN THE TCJA
Timing income and deductions is more challenging under the TCJA because some strategies that taxpayers used to implement no longer make sense. Here’s a look at some significant TCJA changes that have affected deductions:
Reduced deduction for SALT. Property tax used to be a popular expense to time, but with the TCJA’s limit on the state and local tax deduction, property tax timing will likely provide little, if any, benefit for higher-income taxpayers. Through 2025, the entire itemized deduction for SALT — including property tax and either income or sales tax — is limited to $10,000 ($5,000 for married taxpayers filing separately).
If you reside in a state with no, or low, income tax, this change might be less relevant. But keep in mind that deducting sales tax instead of income tax may be beneficial, especially if you purchased a major item, such as a car or boat.
Finally, be aware that increasing or eliminating the SALT deduction limit has been discussed. Check with your tax advisor for the latest information.
Suspension of miscellaneous itemized deductions subject to the 2% floor. This deduction for expenses such as certain professional fees, investment expenses and unreimbursed employee business expenses is suspended through 2025. While this eliminates the home office deduction for employees who work from home (even if your employer has required it), if you’re self-employed, you may still be able to deduct home office expenses.
More-restricted personal casualty and theft loss deduction. Through 2025, this itemized deduction is suspended except if the loss was due to an event officially declared a disaster by the President.
Increased standard deduction. The TCJA nearly doubled the standard deduction. While many higher-income taxpayers will still benefit from itemizing, some—such as those in low-tax states, who don’t have mortgages or who aren’t as charitably inclined—may now save more tax by claiming the standard deduction.
TAX-ADVANTAGED SAVING FOR HEALTHCARE
If medical expenses not paid via tax-advantaged accounts or reimbursable by insurance exceed a certain percentage of your adjusted gross income (AGI), you can claim an itemized deduction for the amount exceeding that “floor.” This floor can be difficult for higher-income taxpayers to exceed. Fortunately, the 7.5% floor that had in recent years been a temporary reduction from 10% is now permanent.
Deductible expenses may include health insurance premiums, medical and dental services, prescription drugs, and long-term-care insurance premiums (limits apply). Mileage driven for health care purposes also can be deducted—at 18 cents per mile for Jan. 1 to June 30, 2022, and at 22 cents per mile for July 1 to Dec. 31, 2022.
You may be able to save taxes without having to worry about the medical expense deduction floor by contributing to one of these accounts:
HSA. If you’re covered by a qualified high deductible health plan, you can contribute pretax income to an employer- sponsored Health Savings Account — or make deductible contributions to an HSA you set up yourself—up to $3,650 for self-only coverage and $7,300 for family coverage for 2022 (plus $1,000 if you’re age 55 or older). HSAs can bear interest or be invested, growing tax-deferred similar to an IRA. Withdrawals for qualified medical expenses are tax-free, and you can carry over a balance from year to year.
FSA. You can redirect pretax income to an employer-sponsored Flexible Spending Account up to an employer-determined limit—not to exceed $2,850 in 2022. The plan pays or reimburses you for qualified medical expenses. (If you have an HSA, your FSA is limited to funding certain permitted expenses.) What you don’t use by the plan year’s end, you generally lose—though your plan might give you a 2.5-month grace period to incur expenses to use up the previous year’s contribution, or it might allow you to roll over up to $570 to 2023. Please note some provisions allowing added FSA flexibility because of the pandemic have expired.
AVOIDING OR REDUCING AMT
The top AMT rate is 28%, compared to the top regular ordinary-income tax rate of 37%. But the AMT rate typically applies to a higher taxable income base. You must pay the AMT if your AMT liability exceeds your regular tax liability. The TCJA substantially increases the AMT exemptions through 2025. This means fewer taxpayers now have to pay the AMT.
In addition, deductions used to calculate regular tax that aren’t allowed under the AMT can trigger AMT liability, and there aren’t as many differences between what’s deductible for AMT purposes and regular tax purposes. This also reduces AMT risk. However, the AMT will remain a threat for some higher-income taxpayers.
So before timing your income and expenses, determine whether you’re already likely to be subject to the AMT—or whether the actions you’re considering might trigger it. In addition to deduction differences, some income items might trigger or increase AMT liability, such as:
- Long-term capital gains and qualified dividend income
- Accelerated depreciation adjustments and related gain or loss differences when assets are sold
- Tax-exempt interest on certain private-activity municipal bonds
Finally, in certain situations exercising incentive stock options (ISOs) can trigger significant AMT liability.
With proper planning, you may be able to avoid the AMT, reduce its impact, or even take advantage of its lower maximum rate.
If you could be subject to the AMT this year, consider accelerating income into this year, which may allow you to benefit from the lower maximum AMT rate. And deferring expenses you can’t deduct for AMT purposes may allow you to preserve those deductions. (But watch out for the annual limit on the state and local tax deduction.) If you also defer expenses you can deduct for AMT purposes, the deductions may become more valuable because of the higher maximum regular tax rate. Finally, carefully consider the tax consequences of exercising ISOs.
If you could be subject to the AMT next year, consider taking the opposite approach. For instance, defer income to next year, because you’ll likely pay a relatively lower AMT rate. Also, before year end consider selling any private-activity municipal bonds whose interest could be subject to the AMT.
Also be aware that, in certain circumstances, you may be entitled to an AMT credit.
If you’re self-employed, you pay both the employee and employer portions of payroll taxes on your self-employment income. The employer portion (6.2% for Social Security tax up to $147,000 of income and 1.45% for Medicare tax with no limit) is deductible above the line. The first half of any 2020 Social Security tax deferred under the CARES Act was due by Dec. 31, 2021, and the second half is due by Dec. 31, 2022.
As a self-employed taxpayer, you may benefit from other above-the-line deductions as well. You can deduct 100% of health insurance costs for yourself, your spouse and your dependents, up to your net self-employment income. You also can deduct contributions to a retirement plan and, if you’re eligible, an HSA for yourself. And you might be able to deduct home office expenses.
Above-the-line deductions are particularly valuable because they reduce your AGI and, depending on the specific deduction, your modified AGI (MAGI). AGI and MAGI are important because they’re the triggers for certain additional taxes and the phaseouts of many tax breaks.
WE'RE HERE TO HELP
To read more tax about tax minimization strategies, you can download a PDF of our Tax Planning Guide here.
We welcome the opportunity to create a personalized tax plan for you and your family. For many clients, providing wealth management and family office services puts us in the unique position to offer the most holistic and advantageous tax planning. The more we know, the more we can do. Most tax minimization strategies must be implemented by December 31, 2022.